Recent IRS Developments — 2008

National Taxpayer Advocate Nina Olson released  her annual report urging Congress to simplify the Code and lessen the burden on taxpayers who cannot meet their tax obligations. The report noted that “[i]f tax compliance were an industry, it would be one of the largest in the United States,” since businesses and individuals spend 7.6 billion hours annually in compliance, at an annual cost of $193 billion, which equals 14 percent of tax revenues collected.

Two examples of complexity cited were the AMT and the legion of Code provisions governing savings for education and retirement. The report concluded that levy and seizure are less effective in collection than offers in compromise and partial-payment alternatives. The report recommended implementation of a “screen[ing]” process to protect low income Social Security recipients from automated tax levies. An estimated 25 percent of taxpayers subject to automatic levies had incomes below the poverty level. IR-2009-003

IRC § 529(b) provides that a qualified tuition program will not be treated as a qualified section 529 program unless such program may not directly or indirectly direct the investment of program contributions. Notice 2001-55 had provided that a program which permits a change in investment strategy once per year will not violate this requirement. In response to the financial crisis, Treasury has announced that for the calendar year 2009, a program that permits a change in investment strategy twice per year will not violate the investment restriction. Notice 2009-1.

The IRS announced the opening on January 16th of an expanded IRS e-file program for 2008 federal returns. New features will allow expanded access to electronic filing, which will result in faster refunds. IRS Commissioner Doug Shulman stated that electronic filing was the preferred method to file accurate returns and receive prompt refunds, which could occur in as few as ten days.  IR-2009-5.

IRC § 6694(a) imposes a return preparer penalty for a return or claim for refund reflecting an understatement of liability due to an “unreasonable position” if the tax preparer knew (or reasonably should have known) of the position. No penalty is imposed if there is reasonable cause for the understatement and the preparer acted in good faith.

Notice 2009-5 states that interim guidance provided by Notice 2008-13, which reflected the 2007 Tax Act, generally held tax preparers to a more stringent standard under IRC § 6694(a) than the “substantial authority” standard imposed by the 2008 Tax Act. Accordingly, when preparing returns for the 2008 tax year, preparers may comply with either Notice 2008-13, or with the less stringent standard imposed by the 2008 Tax Act. (However, tax shelter and reportable transactions must comply with the more stringent Notice 2008-13.)

The 2008 Tax Act provided that a position would be treated as unreasonable unless (i) there was “substantial authority” for the position or (ii) the position was properly disclosed and had a reasonable basis. Notice 2009-5 states that until further guidance is issued, “substantial authority” for purposes of IRC § 6694(a) has the same meaning as in Treas. Reg. §1.6662-4(d)(2) of the accuracy-related penalty regulations.

Treas. Reg. §1.6662-4(d)(2) provides that substantial authority for a position exists if “the weight of authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary treatment. . . Only the following are authority for purposes of determining whether there is substantial authority for the tax treatment of an item: applicable provisions of the Internal Revenue Code and other statutory provisions; proposed, temporary and final regulations construing such statutes; revenue rulings and revenue procedures; tax treaties and regulations thereunder . . . court cases; [and] congressional intent as reflected in committee reports. . . Conclusions reached in treatises, legal periodicals, legal opinions or opinions rendered by tax professionals are not authority. . .”

In PLR 200901020, the IRS expanded the definition of real property for purposes of IRC §1031 to include Residential Development Rights (RDRs). Although “[n]ot all interests defined as real property interests for state law purposes are of like kind for purposes of §1031,” the ruling states the IRS generally looks to state law in determining which rights constitute real property interests. Under state law, RDRs constitute an interest in real estate. Since the RDRs would be held “in perpetuity and are directly related to the taxpayer’s interest, use and enjoyment of the underlying land,” the ruling concluded they were of like kind to a fee interest in real estate.

In PLR 200901004, the taxpayer, in the business of transporting Processed Mineral, proposed to exchange an Old Facility for New Facility, to be constructed by an LLC owned by Domestic Sub. Domestic Sub would continue to use Old Facility, and the taxpayer would begin using New Facility, in their respective trades or businesses. Old Facility and New Facility consist of both tangible and intangible properties. The ruling concluded that since Old Facility and New Facility were “essentially the same type of property,” the relinquished property was essentially of like kind to the replacement property. However, even though no cash is received in the exchange, it is still possible that some of the realized gain must still be recognized, since the exchange is of multiple properties. Under Treas. Reg. §1.1031(j)-1, which governs multiple property exchanges, the exchange must be bifurcated.

If the fair market values of the tangible properties (and therefore the intangible properties) being exchanged are equal, then no gain recognition will occur. However, if the fair market values of the tangible properties are unequal, then some of the realized gain, either with respect to the tangible property received in the exchange (if the fair market value of the tangible property received in the exchange exceeds the fair market value of the tangible property relinquished in the exchange) or with respect to the intangible property received in the exchange (if the fair market value of the intangible property received in the exchange exceeds the fair market value of the intangible property relinquished in the exchange) will have to be recognized. Note that even though some gain will be recognized in this situation, the corresponding loss — and there will always be a corresponding loss which mirrors the gain — will not be recognized because realized losses are not recognized in a like kind exchange (IRC § 1031(c).

In PLR 200901023, the taxpayer established a Trust to “manage, conserve and distribute” her deceased husband’s art works. The works would be made available for exhibition in public galleries and museums throughout the world, but principally in Country B and in the United States. Items not on public exhibition would be available for viewing by arrangement with the trustees. The trustees were authorized to sell items within the collection to provide funding for future activities as an addition to the original endowment funding. The ruling sought clarification as to whether the gift or bequest to the Trust would qualify for a gift tax deduction under IRC §2522, or for an estate tax deduction under IRC §2055.

The ruling first noted that the estate tax deduction is not limited to transfers for use within the United States, and then cited Rev. Rul. 66-178, which found that an organization created to “foster and develop the arts by sponsoring an annual public exhibition at which art works of promising but unknown artists” were displayed was exempt from income tax under IRC § 501(c)(3). The ruling concluded that “[l]ike the organization described in Rev. Rul. 66-178, Trust is created to foster and develop the arts by sponsoring public exhibitions of art work.” Accordingly, the ruling concluded that gifts to the Trust qualify for the gift tax charitable deduction, and bequests to the Trust qualify for the estate tax charitable deduction.

In PLR 200901008, Buyer 1 purchased a 50-year estate for years in Property (the “Lead Interest”) and Buyer 2 purchased a remainder interest in the Property. Buyer 2 intends to hold the remainder interest as a long-term investment. The ruling stated that no income, gain or loss will be recognized to Buyer 2 either at the time of purchase or when the remainder interests vests in possession. The holding period for the remainder interest of Buyer 2 commences on the day after Buyer 2 purchases the remainder interest from Sellers.

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